Car Lease vs Loan: What Should I Choose?
- September 12, 2023
- by Angela
Many people are thinking about buying a car, but they are not sure how to go about financing it. Should they do it with the help of a car lease or should you apply for a personal car loan? What is the difference between a car lease and a personal car loan? You will get answers to these and other similar questions in this article.
What is a car lease?
If you want to spend less money on a car in terms of a monthly payment, leasing a car is the right solution for you. What does that mean? Leasing a car is also called a personal contract rental. In other words a lease is like renting. With a lease you pay an up front deposit. Then each month you pay a certain amount of money to “rent” the car.
The contract specifies how long the lease lasts (typically 1 to 3 years). When the contract expires, you must return the car to the dealer. You will be required to carry a certain amount of insurance on the car. You will also be required to take it in for scheduled maintenance.
There is a pre-set limit on how many miles you can drive each year (10,000 miles, 15,000 miles, etc). If you exceed that limit when the lease ends you will owe extra fees.
A lease also comes with some downside protection because the depreciation is baked into the contract. So if the market value of the car plummets unexpectedly, you are only on the hook for the down payment and the lease payments. If the value of the car is worth more than expected at the end of the lease this is good for you. Most contracts will give you the option to buy out the lease and sell the car separately then pocket the difference.
What is a loan?
If you decide on a personal loan for a car, it works differently compared to leasing. When you take out a loan, you are buying the car. While you are making payments, the bank holds a lien on the title. This means you own the car, but can’t sell it until the loan is paid off. If you fail to make payments the bank can repossess the car to cover the balance. With a loan you can vary the number of months until the loan is paid in full. The shortest duration is 36 months = 3 years and the longest is up to 84 months = 7 years. Your credit rating, the price of the vehicle, your down payment, and the length of the loan will determine your interest rate. Check out our auto loan calculator to play with a few scenarios on your own.
When you pay it off, the car is completely yours. Repairs are entirely up to you after the warranty expires. In the first few years of the loan you are likely to be “under water” on the car, which means you owe more than it is worth. That can be a big problem if you decide you want a new vehicle.
Differences between car leases and loans
There are big differences between leasing a car and taking out a car loan. As for leasing, it is suitable for those people who will use the car for a short time, but even for that short time, they need to pay attention to certain things.
Key factors to keep in mind about a lease:
- When the lease is over you must return the car to the dealer from which you took the car on lease. This means you’ll be car shopping all over again in 1-3 years, which can be stressful!
- If you exceed the mileage limit, you will pay a penalty for every extra mile.
- If you return the car damaged at the end of the leasing contract, you will pay for the repair of the car! Hopefully this is something your insurance can cover though.
- New cars almost all have at least a 3 year bumper to bumper warranty, so if anything major goes wrong you don’t have to pay. New car tires typically last that long as well, so there shouldn’t be any major maintenance except a few oil changes.
When you take out a car loan you:
- Your loan term sets your minimum monthly payment and how many payments there are.
- You can pay ahead on the loan if you like to pay it off early.
- When you pay off the loan, the car becomes yours! If you plan to keep the car for 10-15 years this can be a good way to go.
- Since this is a long term arrangement, you will be on the hook for major maintenance (tires, 60k services, brakes, etc).
- It is your car from day 1, so you can put as many miles on it each year as you like!
Pros and cons of car lease
Pros for car leasing
- Can be cheaper from a monthly payment perspective.
- Down payments are usually small compared to a loan down payment.
Cons of leasing a car
- Looking at total cost of ownership, years 1-3 are the steepest part of the depreciation curve and you are basically agreeing to be stuck with that.
- You have to go back to the dealer when the lease is up to either get a different car or buyout the lease (which may or may not be a good deal).
- When you lease a car, you do not own it, you only rent it,
- If you exceed the mileage limit, you must pay for the excess mileage,
- If you damage the car, you are obliged to pay the costs of repairing the car.
Pros and cons of a personal loan
A personal loan to buy a car is much more favorable if you have an excellent credit score. Below we will see the pros and cons of a personal loan for the purchase of a car:
Personal loan application
- If you have a good credit score, you can have a lower interest rate when taking out a car loan.
- If your credit is good enough there will be a zero down payment.
- Total cost of ownership when taking out an auto loan is lower vs a lease, especially if you plan to hold the car for a long time.
- When you buy a car on loan, it is yours and you can do whatever you want with it. After you pay it off you can sell it, let your kid drive it, whatever you like.
Cons for a personal loan:
- If you want the best interest rates, it is crucial that you have an excellent credit score.
- Monthly payments can be higher vs a lease.
- You are “stuck” with the car, and it is hard to say what it will be worth in 3-5 years, vs with a lease that is already calculated. This is actually a pretty small risk though as the lease contracts have lots of moving parts and they are able to obscure this - the dealers make more money on the lease.
Conclusion: If you need a car for the short term, a lease is a good way to go. Many businesses lease cars because it simplifies tax treatment of the write off. If you are looking to buy a car and keep it for a long time a loan would be better overall, but it depends on your credit rating.
See our additional auto related personal finance articles: